Risk mitigation effect of foreign debt: evidence from loan pricing

Abstract

PurposeThe author examines the presence of foreign currency effects and the risk-mitigation channel through which a foreign-currency denomination reduces the loan spread.Design/methodology/approachThe author runs regression analyses using loan data of firms incorporated in member countries of the Association of Southeast Asian Nations (ASEAN) from 2000 to 2020. The author also runs several robustness tests to address forward exchange rate bias, endogeneity concern and sample-selection bias.FindingsConsistent with the currency matching motive of foreign debt use, the results show that a foreign currency denomination is associated with a lower spread and the relationship is amplified when there is a positive correlation between the changes in the return on assets and in the exchange rate.Research limitations/implicationsThis paper enriches existing studies on the use of foreign debt as an exchange rate risk management tool.Practical implicationsThe results suggest that as firms utilize foreign debt and policymakers need to design banking regulations that not only oversee but also encourage the use of foreign debt as a hedging instrument to lower firms' borrowing costs.Originality/valueThis paper contributes to extant studies by examining the presence of foreign currency effects in emerging countries' loan markets and by exploiting the micro-level demand-side factors as the channel through which the currency denomination affects the loan spread.